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No 23 (October 2000/Octobre 2000/Oktober 2000)
To ensure a high level of protection for the rights of future pensioners, the Commission has presented a proposal for a Directive on institutions for occupational retirement provision (pension funds, superannuation funds etc). The aim is to create a prudential framework. The proposal also seeks to ensure that institutions enjoy sufficient freedom to develop an effec-tive investment policy. They must thus be able to invest sufficiently in shares, as in the long run these have generally offered good returns and make it possible to link pension promises to growth in productivity and in the real economy. Institutions will be able to benefit from the greater depth and liquidity of the capital markets resulting from the introduction of the euro, thereby increasing the effectiveness and security of their investments. The proposal for a Directive also seeks to enable an institution in one Member State to manage company pension schemes in other Member States.
In the words of Internal Market Commissioner Frits Bolkestein: "Institutions for
occupational retirement provision play a major role in promoting social cohesion
in many Member States and in financing Europe's economy. In view of the
ageing of the Union's population, such institutions must be able to operate with
the utmost security and efficiency. The security of pensions is of prime
importance: the rights of future pensioners must be protected by strict
prudential standards. But the cost of pensions must also be borne in mind.
Benefits must not become too costly through low returns or excessive
administrative constraints. Firms' competitiveness would be affected, the
financial equilibrium of pension schemes would be more difficult to achieve and
pensioners might receive less in the way of benefits. Consequently, the proposal
for a directive seeks to ensure both the security and the affordability of
occupational pension schemes."
The proposal concerns institutions for retirement provision that are linked to employment and operate on a funded basis, such as pension funds, Pensionskassen and life assurance companies when they provide occupational pension products. These institutions are the last major financial service entities not to enjoy the benefits of an Internal Market legislative framework. They currently hold assets that amount to about e 2,300 billion and cover 25 % of the EU population. They must be able to benefit fully from the advantages of the Single Market and the euro without being hampered by unnecessary restrictions. These institutions are very well developed in the UK, the Netherlands and Ireland. They are becoming increasingly important in Germany. The proposal does not cover basic state pay-as-you-go schemes. It does not deal either with purely individual pension saving plans.
It is vital that future pensioners' means of subsistence should enjoy a very
high level of protection. But IORPs must also operate efficiently, particularly
as regards financial investments and cross-border transactions. An improvement
in performance, however small, can in the long run greatly reduce the cost of
benefits. Inadequate protection, on the other hand, places retirement benefits
at risk. A lack of efficiency increases the cost of saving, to the detriment of
firms' competitiveness and pension schemes' financial equilibrium.
Strict prudential rules
Adequate investment rules
Organising social protection and pension schemes is a matter for the
Member States alone. It is to Member States to decide how they cope with
population ageing. The choice between pay-as-you-go schemes and funded schemes,
the balance between these schemes and the encouragement of this or that form of
retirement saving are entirely up to them.
Above all, this Proposal aims to establish a high-level of protection for the rights of pension beneficiaries. It therefore contains rigorous prudential and investment standards.
The Proposal also seeks to establish the right for institutions for retirement provision to manage pension schemes on a cross-border basis (which is currently not possible). A large multinational could save up to ± e 40 million if it could pool all its pension schemes in one fund instead of running different funds in each Member State.
This proposal, by harmonising prudential requirements, is a first step in this regard. A second step will consist in giving the right to companies and employees to obtain tax relief on contributions paid to institutions situated in other Member States. The Commission will come forward with appropriate initiatives early next year.
Under this proposal, the fund would be subject to the investment and prudential
rules of the Member State where it was established. But it would have to respect
the labour and social requirements (i.e. rules of the scheme, types of benefits
provided) that are in force in the Member State where the employer and employees
are established, as social and labour provisions are not yet harmonised at EU
Security comes first. That is why the Commission has proposed a global prudential framework, with rules on such issues as assets, liabilities and information for beneficiaries. The whole proposal is designed to prevent another Maxwell scandal notably by requiring a clear distinction between the sponsoring company and the fund, by imposing on-going prudential control and by requiring that the fund always holds sufficient assets to cover its commitments.
Separation principle. There would have to be a legal separation between the institution running the pension scheme and the organisation paying contributions to the institution.
Conditions of activity. There would have to be prudential supervision by a competent authority of the conditions under which the scheme was operated based on certain criteria: competence and good repute of managers/directors, existence of rules regarding the functioning of the scheme, proper professional calculation of technical provisions etc.
Information and supervision. Ongoing financial supervision would have to be on the basis of annual accounts and the annual report, which would have to be made available on request to members and beneficiaries of the pension scheme. The pension institution would have to disclose every three years (or following any significant policy changes) information on the principles underlying their investment policy, including a description of risk management methods. The supervisory authority would then have to be able to compare whether actual investments were being made according to the principles laid out. This is one way of obliging managers to take a strategic and long-term view on how to manage assets and liabilities.
Powers of the supervisory authorities. They would have to have sufficient information and powers to intervene to safeguard the interests of members and beneficiaries, including the right to on site inspections including of any functions that the pension institution has out-sourced.
However, adequate regulation of these institutions would not be only about
security. It would also pay attention to the cost of pensions. If this cost is
too high, everyone loses out: in final salary schemes, employers have to
contribute more for a given level of benefits, with a negative impact on labour
costs. In money-purchase schemes, employees end up with smaller benefits. And in
addition, the financial sustainability of pension systems remains fragile with a
heavy burden on taxpayers.
The prudent-person principle requires managers to always hold a well-diversified
investment portfolio that matches the nature and duration of the commitments
(i.e. pension promises). But it gives these managers sufficient flexibility to
decide on how the most appropriate diversification can be achieved on a
Institutions for Occupational Retirement Provision are major investors. They manage about ± e 2.300 billion now. This figure is expected to rise to about ± e 3.500 billion in 2005. The figure could become higher if more Member States decide to favour the development of funded occupational schemes in order to cope with evolving demographic and budgetary situations. In addition, no other type of institution invests with such a long-term horizon (about 40 years).
There would be considerable advantages in such huge financial resources being
invested in the real economy (through equity and risk-capital markets) so as to
boost the EU economy by fostering growth and employment, instead of being used
to finance public deficits. Ideally, long-term commitments should be linked to
assets like equities that perform well over the long term. Investments in
short-term and liquid assets such as bonds are only suited to commitments
reaching maturity in the near future (five years or less). The trends towards
more funded schemes and increasing investment into shares would give a rise to a
stronger demand for financial instruments and accelerate the shift from
bank-based financing to market-based financing which is cheaper and more
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